E = BTC: the energy cost of bitcoin

Earlier this year, it was reported that a Russian businessman, Aleksey Kolesnik, had bought two electric power stations solely to meet the electricity requirements for Bitcoin data mining ventures. Similarly, there are stories of Bitcoin miners migrating to towns in Alberta, Oregon, and Iceland, where cheap electricity awaits cryptocurrency entrepreneurs.

One of the lesser known facets of cryptocurrencies like Bitcoin is the high energy requirements of the mining process. These requirements are causing the gold rush-like movements to areas with cheap electricity.

This electricity need is a result of data mining. To understand cryptocurrency data mining, let’s recap how Bitcoin is generated.

In the modern economy, transactions between entities are validated by third parties in whom we have collectively put our trust. For example, when we pay for products with credit cards, we allow our banks to act as the middleman between us and the merchant. Third parties — from individual accountants, notaries, banks, to entire governments of nations — facilitate and approve transactions to ensure fairness and prevent fraud.

The cryptocurrencies, which began with Bitcoin, were innovative in that they eliminated these middlemen by using Blockchain and the proof-of-work (PoW) model, which ensure unparalleled reliability in the absence of bureaucracy.

A blockchain, as its name suggests, consists of a chain of ‘blocks,’ with each block containing three kinds of information: transaction data, an identifier called hash, and the hash of a previous block to which it is linked. The blockchain acts as a history of all transactions relating to the relevant Bitcoin. It accounts for every Bitcoin in circulation and is available to any user.

Once a transaction is made, it needs to be validated so as to prevent fraudulent activity — in essence, a block needs to be added to the chain. This is where the mining comes in. Miners looking for Bitcoin provide computing power to verify the transaction and compile it into the blockchain. They compete with each other to solve a unique and complex mathematical problem associated with the transaction. Solving the mathematical puzzle is what constitutes blockchains’ PoW.

“You can think of them as mathematical puzzles where, actually, every 10 minutes, there is a new puzzle… and whoever has the resource to find a solution can go and then use that solution to basically certify the last 10 minutes worth of transactions,” said Yuri Takhteyev, a status-only professor at the Faculty of Information, describing the mining process.

As a solution is found for a puzzle, it is communicated across the network and all other miners stop work on that block — which is then added to the blockchain — and move on to the next one.

The mining process thus has two purposes: to confirm transactions by devoting computational work for each block and to release new bitcoins into the system by awarding them to the Bitcoin miner who performed the work. “The important part about it is that it is basically something that you could only solve by trial and error,” explained Takhteyev.

Here lies the problem in the effectiveness of the model. The prize for this effort, currently at 12.5 bitcoins, can mean a windfall of tens of thousands of dollars depending on the value of the extremely volatile currency. Wastefully, the inherent competition in the PoW model where the miners work to find the last link of the single blockchain puzzle only awards a prize to the miner who resolves the puzzle, while a great amount of energy is used by other users in hopes of drawing the right combination.

Like gold in the ground, Bitcoin is a finite resource estimated to total 21 million in number, and despite its already high value, its value is expected to appreciate over time. That is why, even with this systemic inefficiency, data mining centres or ‘farms,’ sometimes each operating thousands of mining machines, have sprung up. To offset operational costs, such ventures seek cheap forms of electricity, sometimes in the form of non-renewable sources.

The Digiconomist website, through its Bitcoin Energy Consumption Index, estimates that Bitcoin ventures consume electricity at an annual rate of 58.7 Terawatt hours. This is greater than the electricity needed to power the entire countries of Greece or Algeria for the same amount of time. Only 43 countries have a higher annual energy consumption than Bitcoin mining.

To combat the inefficiency of the PoW model, it has been rumoured that Ethereum, the second largest cryptocurrency, is planning to phase out their PoW model to a Proof of Stake model. The Proof of Stake model follows a deterministic path where the creator of a new block in the chain is chosen based upon selectable criteria, such as their share in a currency, and takes a transaction fee. This reduces the competition, and thus inefficiencies in data mining.

Each Bitcoin transaction is estimated to release over 444 kilograms of carbon dioxide into the atmosphere. “In the days when we’re all worried about global warming, you are just going and burning energy for nothing,” said Takhteyev.

Thus, with its great demand for resources, for Takhteyev and perhaps many others, this move away from the Bitcoin model marks a step in the right direction.

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Cryptocurrency 101

By now, many people have probably heard of Bitcoin and cryptocurrency. It’s also safe to say that many people do not fully understand what Bitcoin and cryptocurrency are. Here is a breakdown of cryptocurrency: what it is, how it works, and why it was developed in the first place.

What is cryptocurrency, anyway?

Cryptocurrency is a digital form of currency that is transferred directly between two individuals without a middleman. It’s not tangible like cash, coins, or gold — it exists only digitally. To secure transactions, cryptocurrency makes extensive use of encryption techniques, or cryptography, which gives the currency its name.

All transactions are chronologically recorded on a public, digital ledger referred to as a ‘blockchain.’ Essentially, ‘blocks’ of information pertinent to recent transactions — payer identity, amount transferred, payee identity, and the like — are continuously added to a ‘chain.’ Of course, there is no physical blockchain; it only exists digitally.

Traditionally, the transaction history of bank credit is centralized under one authority, and banks can devalue dollars by printing more money. If, however, bank credit were decentralized, there would no longer be a need for a central bank to keep ledgers and banks would no longer be able to control value. Therefore, decentralization protects currency from inflation.

Blockchain is unique because it uses distributed technology in which transaction history is decentralized. In other words, the information is public, stored at multiple sites rather than just one, and can be verified by multiple users. This idea of a decentralized currency is where cryptocurrency finds its value and is part of what makes cryptocurrency so revolutionary.

What’s the big deal?

The sudden hype around cryptocurrency may be because Bitcoin, the leading cryptocurrency, peaked at about $20,000 per coin in December 2017, overwhelmingly exceeding its initial value of $0.06 per coin in 2010.

This means that if you had invested your $10 lunch money into Bitcoin back then, your investment would now be worth over $2 million. If you had cashed out at the peak in December, you would now have over $4 million.

Over the past year, Bitcoin has gained momentum and its value has accumulated exponentially, leading many to dub 2017 as “The Year of Bitcoin.”

When and why did this all start?

It all started with Bitcoin in 2009. It is unknown who founded Bitcoin, but we do have the pseudonym of its creator: Satoshi Nakamoto. If this mysterious entity is one individual and not a group, then Nakamoto is potentially a billionaire.

Bitcoin was created to deal with the problems of the current financial system — using it, at least initially, resulted in faster payments than traditional ways of transferring money through a bank, lower transaction fees, and all the perks of decentralization.

On campus, student groups like the University of Toronto Decentralized Tech Association have recognized the importance of cryptocurrency and hold discussions and information sessions to promote this technology.

How many types of cryptocurrencies exist?

There are now over 1,500 different cryptocurrencies that exist. Bitcoin is seen as the founding currency, and all of the other cryptocurrencies are referred to as ‘altcoins.’

Altcoins promise improvements upon Bitcoin’s design, like faster transactions from Litecoin, better security and privacy from Monero and Zcash, or some other factor that makes them superior, like Ethereum’s smart contracts, which facilitate these transactions.

One year ago, Bitcoin had a market dominance of 87 per cent in the cryptocurrency world, but it now has under 40 per cent, which indicates that the influence of altcoins has been growing exponentially.

The value of the altcoins generally follows the value of Bitcoin — when Bitcoin passed $20,000 in early December, a massive growth in the value of altcoins followed. Since Bitcoin’s slight decline in the past month or so, altcoins have also been decreasing in value. The cryptocurrency market is highly volatile, but some investors find this beneficial because they can ‘buy the dips,’ or buy cryptocurrencies at lower prices.

Is there a link between cryptocurrency values and the stock market?

There may be a connection between Bitcoin and the stock market. The Dow Jones Industrial Average — an indication of stock market performance — fell more than it ever has in a single day in early February 2018. That day, Bitcoin and altcoins also experienced a dip in value. Some people believe this is because people want to sell off their risky assets when either cryptocurrencies or the stock market falls. Therefore, a dip in either cryptocurrency or traditional currency can cause a sell-off in the other.

Why are the prices of cryptocurrencies so volatile?

The market will continue to be volatile because many speculate about the true value of Bitcoin. Although some cryptocurrencies can be used to purchase items and goods from some vendors, most mainstream goods and services still do not accept it as payment. Cryptocurrencies are only worth what people believe them to be worth, and many see them as being in a bubble that will soon pop, believing that the value of cryptocurrencies will drastically plummet.

On February 17, 2018, Vitalik Buterin, the founder of Ethereum — the second largest cryptocurrency — tweeted: “Reminder: cryptocurrencies are still a new and hyper-volatile asset class, and could drop to near-zero at any time.”

A major reason cryptocurrency values have recently declined is because several governments, like those of China, South Korea, and Russia, plan to impose heavy restrictions or regulations on cryptocurrency exchanges or ban them altogether.

On the other hand, cryptocurrencies have nonetheless been growing exponentially in value over the last few years. This is not only because people want to make quick, easy money, but also because many are starting to realize the tremendous potential of this sort of technology. Cryptocurrency will likely be around for a long time and will play a significant role in how we make transactions in the future.